Executive Compensation Under Section 503(c) – The Sports Authority Story

by Bryan Cave
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A recent, and highly publicized, decision from the case formerly known as Sports Authority, In re TSA WD Holdings, Inc. et al., Case No. 16-10527 (MFW), Bankr. D. Del. (Docket #2863, Aug. 31, 2016), allowed the defunct company to pay three unnamed senior executives $1.425 million in “incentive pay” to remain with the company and oversee its liquidation.[i]  Judge Mary Walrath granted Sports Authority’s[ii] Motion for Order (A) Approving Modified Executive Incentive Program and Authorizing Payments Thereunder and (B) Authorizing the Debtors to File the Unredacted Modified Key Employee Incentive Program Under Seal (Docket #2746) (the “EIP Motion,” a copy of which is here) over the strenuous objection of the U.S. Trustee (Docket #2809) (the “UST Objection,” a copy of which is here), and only after she had denied a similar from the Debtors request a month earlier.  More importantly, Judge Walrath authorized the incentive payments in a case where Sports Authority’s primary assets had already been liquidated, Debtors would almost certainly pay nothing to unsecured creditors, and the estate may or may not be administratively insolvent.  The Sports Authority example is informative for three reasons: 1) it demonstrates how a company that needs to keeps its top executives in place, post Chapter 11 filing, can structure an incentive package; 2) it reinforces the requirement to evaluate any incentive package that pays insiders under Section 503(c); and (3) it demonstrates that a debtor’s ability to push through an incentive package is not dependent on the solvency of the estate.

Background of the Case

On March 2, 2016, Sports Authority and its subsidiaries filed voluntary Chapter 11 cases in Delaware.[iii]  At the time of filing, Debtors filed a Sales Motion pursuant to Sections 105, 363, and 365 of the Bankruptcy Code.[iv]  Debtors then solicited interest in substantially all of their assets, including their leasehold interests, inventory, and FF&E.[v]  Debtors did not receive any going concern bids for their assets on an enterprise level.  Instead, Debtors were forced to accept a bid from a joint venture for their retail inventory.[vi]  On May 24, 2016, the Court issued a Sale Order approving the sale of substantially all of Debtors’ retail inventory.  Debtors had liquidated substantially all their assets by August 10, 2016.[vii]

On July 12, 2016, Debtors filed a Motion for Order Approving Executive Incentive Program (Docket #2478) (the “First EIP Motion,” a copy of which is here).  The Executive Incentive Program (“EIP”) would have paid four of Debtors’ top executives up to $2,825,000 “to continue to provide services required of their existing positions with the Debtors, fully support the liquidation process and Chapter 11 Cases, and execute a release of claims . . . .”[viii]  Payments under the EIP were to be funded by Debtors’ Term Loan Agreement.[ix]  As such, Debtors stated in the First EIP Motion that they were seeking the Court’s approval out of an abundance of caution, that there was sufficient business justification for the incentive payments, and that Section 503(c) was not applicable to the incentive payments because they were not “Administrative Expenses of the Estate.”[x]  The U.S. Trustee objected to Debtors’ First EIP Motion (Docket #2602, a copy of which is here).  The U.S. Trustee argued that the EIP was subject to Court approval, that Section 503(c) applied to the EIP, and that the EIP did not pass muster under Section 503(c).[xi]  On August 2, 2016, the Court held a hearing on the First Motion.  At the hearing, the Court sided with the U.S. Trustee, entering an order (Docket #2720, a copy of which is here) denying Debtors’ First EIP Motion.[xii]

Undeterred by the Court’s denial, the Debtors brought the next EIP Motion. Debtors drastically altered the EIP for the second go-around and, perhaps most crucially, analyzed the EIP under Section 503(c).[xiii]  “The metrics included in the Original Incentive Plan [were] replaced and . . . Participants will [now] only be entitled to incentive bonus payments if the Debtors are able to (a) trigger the sharing provisions provided for in the Agency Agreement, and (b) achieve a considerable cost-savings relative to the Controllable Costs included in the Wind-Down Budget.”[xiv]  Despite Debtors’ changes to the EIP, the U.S. Trustee filed an objection to the EIP Motion stating that the incentive payments were still “impermissible insider retention bonuses, and the motion should be denied.”[xv]  Debtors prevailed, in an order that is here.

Takeaways

The Court authorized Sports Authority’s modified EIP after denying its initial EIP program, and over the U.S. Trustee’s Objection, for two reasons. First, Debtors sought relief under the appropriate provisions of the Code.  Instead of offering the Court a cursory review of the Debtors’ justification as was done in the First EIP Motion, the EIP Motion carefully justified the modified EIP explaining why it could be approved under Section 503(c)(3).  The EIP Motion set forth the reasons why “the payments incentivize and reward achievement of performance based on specific goals and targets and to do not provide payment for retention or severance . . . .”[xvi]

Second, Debtors showed how the program conformed to the statute, setting hard metrics that delineated executive performance. While the original EIP offered incentive payments for rather amorphous accomplishments like “inventory shrinkage levels” and “controllable wind-down costs,” the modified EIP provided tangible metrics referencing inventory reduction levels to those set forth in the Agency Agreement and setting cost controls relative to the numbers in the Wind-Down Budget.[xvii]  Sports Authority convinced the Court that the modified EIP satisfied Section 503 because it fit neatly into Section 503(c)(3) and was not subject to the restriction of  Sections 503(c)(1&2).  Because the modified EIP fit into Section 503(c)(3), the Court could apply the business judgment standard of Section 363(b) to the modified EIP.  That standard allowed the Court to approve the modified EIP regardless of the financial condition of Debtors’ estate.  The modified EIP also did away with fixed payments for the “Participants remaining employed with the Debtors through certain agreed upon dates.”

Debtors’ attempts to circumvent Section 503(c)’s requirements and failure to conform the First EIP Motion to the statute cost them more time and two rounds of briefing. Ultimately, the Court granted the EIP Motion because Debtors provided the Court with a payment structure it could approve under Section 503.  The Sports Authority case provides a road map for how a debtor can keep its executives in place even though incentive payments to those executives may not be embraced by the debtor’s creditors or its former employees.

A Sidenote

Debtors also prevailed in their attempts to withhold the names of the executives benefitted by the EIP. Over the U.S. Trustee’s Objection, the Court allowed the Debtors to file the actual EIP under seal.  Neither the public nor Sports Authority’s former employees will know which of Debtors’ executives received incentive payments for their work winding down the company.

[i]           All docket references that follow refer to the docket in In re TSA WD Holdings, Inc. et al., Case No. 16-10527 (MFW), Bankr. D. Del.  Debtors in the consolidated Case No. 16-10527 (MFW) may hereafter be referred to as “Debtors” or “Sports Authority.”

[ii]           Sports Authority is controlled by TSA WD Holdings, Inc., which is currently the Debtor in Possession in Case No. 16-10527, the jointly administered case for all of Sports Authority’s entities currently in Chapter 11.

[iii]          EIP Motion (Docket #2746) at ¶ 8.

[iv]          Id. at ¶ 10.

[v]           Id. at ¶ 11.

[vi]          Id.

[vii]         Id. at ¶ 2.

[viii]         First EIP Motion (Docket #2478) at ¶ 14.

[ix]          Id. at ¶ 10.

[x]           Id.

[xi]          First UST Objection (Docket # 2602).

[xii]         Order on First EIP Motion (Docket # 2720).

[xiii]         EIP Motion (Docket #2746) at ¶¶ 20-29.

[xiv]         EIP Motion (Docket #2746) at ¶ 4.

[xv]          UST Objection (Docket #2809) at ¶ 1.

[xvi]         EIP Motion (Docket #2746) at ¶ 21.

[xvii]        The Agency Agreement and Wind-Down Budget were previously approved by the Court as part of the Sale Order (Docket #2081).

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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